First Financial Corporation — 2017 Form 10-K
Business context and period: Financial holding company headquartered in Terre Haute, Indiana, operating primarily in west-central Indiana and east-central Illinois. Its businesses include commercial, mortgage and consumer lending, deposits, trust services and related financial services. This filing covers the fiscal year ended December 31, 2017; amounts below are U.S. dollars.
Financial performance and condition
| Metric | 2017 | 2016 |
|---|---|---|
| Net income | $29.1 million | $38.4 million |
| Diluted earnings per share | $2.38 | $3.12 |
| Interest income | $114.2 million | $109.4 million |
| Net interest income | $107.9 million | $105.0 million |
| Net interest margin | 4.11% | 4.04% |
| Provision for loan losses | $5.3 million | $3.3 million |
| Non-interest income | $35.9 million | $46.9 million |
| Non-interest expense | $88.7 million | $90.3 million |
| Return on average assets | 0.98% | 1.30% |
| Return on average shareholders’ equity | 6.69% | 9.26% |
- Balance sheet: Total assets were $3.00 billion, loans were $1.90 billion, securities were $814.9 million, deposits were $2.46 billion and shareholders’ equity was $413.6 million at year-end. Versus 2016, assets increased 0.4%, loans increased $67.6 million, deposits increased $30.1 million and securities declined $38.8 million.
- Cash flow: Operating activities provided $50.1 million; investing activities used $26.7 million; financing activities used $24.4 million. Cash and due from banks ended the year at $74.1 million, down $0.9 million. These figures are consolidated cash flows, not a measure of bank regulatory liquidity.
- Borrowings and liquidity: Short-term borrowings were $57.7 million, down from $81.0 million; other borrowings were zero. Management cited securities maturities, mortgage-backed-security principal payments and available secured and unsecured borrowing capacity as liquidity sources. It estimated $5.3 million of investment maturities, $98.3 million of mortgage-backed principal payments and $25.3 million of securities calls over the following 12 months.
- Capital: At December 31, the Corporation reported CET1 of 17.01%, total risk-based capital of 17.88% and leverage capital of 13.31%. The Bank reported 16.56%, 17.30% and 12.81%, respectively. The filing states both subsidiary banks were well capitalized.
- Credit quality: The allowance for loan losses was $19.9 million, or 1.04% of loans, compared with $18.8 million, or 1.02%, in 2016. Net charge-offs were $4.2 million versus $4.5 million. Nonperforming loans declined to $21.7 million from $22.7 million; loans past due 90 days and still accruing increased to $1.4 million from $0.6 million.
Material changes and unusual items
- Net income fell about 24% year over year. The 2017 result included a $6.3 million non-cash income-tax expense from remeasuring deferred tax balances following the Tax Cuts and Jobs Act; the reported effective tax rate was 41.5%, versus 34.1% in 2016.
- 2016 earnings benefited from a $12.8 million pre-tax gain on the sale of insurance brokerage assets and liabilities, reported as an after-tax gain of approximately $5.8 million. The sale reduced 2017 insurance commissions and left the Corporation more focused on core banking.
- Net interest income increased as average earning assets and yields rose, but interest expense also increased. The loan-loss provision rose 60.5%, reflecting, among other factors, higher impaired loans and allocated reserves.
- Year-end deposits rose despite a decline in non-interest-bearing deposits; short-term borrowings decreased. The allowance coverage ratio for nonperforming loans increased to 92% from 83%.
- The Corporation paid a $1.50-per-share special dividend in December. The filing reports 2017 dividends of $2.51 per share in selected data and the equity statement, while the MD&A describes $2.50 per share paid; verify the difference and declared-versus-paid basis. The reported dividend payout ratio was 105.3%.
Outlook, risks and contingencies
- Management expected gradual Federal Reserve rate increases during 2018 and said a generally low-rate environment was expected to continue. The Corporation described itself as asset-sensitive; modeled net interest income rises under rate increases but falls under rate decreases. These simulations rely on assumptions and are not forecasts.
- Management expects regular cash dividends to continue, subject to earnings, capital needs and regulatory restrictions. The elevated 2017 payout ratio and special dividend merit attention; future dividends are not assured.
- Material risks include geographic concentration, borrower and collateral deterioration, competition and technology disruption, cybersecurity and vendor dependence, regulatory change, interest-rate sensitivity and uncertainty around LIBOR’s transition after 2021.
- The Corporation was preparing for the expected-credit-loss standard (CECL), effective for it after December 15, 2019. Management anticipated an increase in the allowance at adoption, but said the amount was uncertain.
- Unused loan commitments totaled $387.7 million and commercial letters of credit totaled $5.0 million. These are contingent commitments and do not necessarily represent future cash outflows. The filing reported no material pending legal proceedings beyond routine litigation.
- Management concluded internal control over financial reporting was effective; the independent auditor issued unqualified opinions on the financial statements and internal controls.
Most important facts for investors to verify
- How much of the earnings decline reflects the one-time $6.3 million tax remeasurement and the absence of 2016’s insurance-sale gain, versus underlying operating trends.
- Whether the higher loan-loss provision, impaired commercial loans and increase in 90-day accruing delinquencies signal further credit deterioration; assess allowance adequacy and consumer-loan charge-offs.
- The sustainability of net interest margin as deposit costs rise, and the sensitivity of earnings to actual rate paths versus management’s modeled scenarios.
- The source and sustainability of dividends, including the payout above net income and the filing’s $2.50/$2.51 per-share discrepancy.
- The eventual CECL allowance impact, remaining LIBOR-linked exposures and transition arrangements, and the valuation assumptions for less-liquid securities and collateral-dependent assets.